Pairs Trading In The Index Options Market

Marianna Brunetti and Roberta De Luca ()
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Roberta De Luca: Bank of Italy

No 512, CEIS Research Paper from Tor Vergata University, CEIS

Abstract: We test the Index options market efficiency by means of a statistical arbitrage strategy, i.e. pairs trading. Using data on five Stock Indexes of the Euro Area, we first identify any potential option mispricing based on deviations from the long-run relationship linking their implied volatilities. Then, we evaluate the profitability of a simple pair trading strategy on the mispriced options. Despite the signals of potential mispricing are frequent, the statistical arbitrage does not produce significant positive returns, thus providing evidence in support of Index Option market efficiency. The time-to-maturity of the options involved in the trade as well as financial market turbulence have a marginal effect on the eventual strategy returns, which are instead mostly driven by the moneyness of the options traded. Our results remain qualitatively unchanged if a stricter definition of reversion to the equilibrium is applied or when the long-run relationship is estimated on an (artificially derived) time series of options prices rather than on options’ implied volatilities.

Keywords: pairs trading; option market efficiency (search for similar items in EconPapers)
JEL-codes: C44 C5 G10 G12 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2021-09-02, Revised 2021-09-02
New Economics Papers: this item is included in nep-cfn, nep-cwa and nep-eec
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Journal Article: Pairs trading in the index options market (2023)
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